Does the stimulus have a future?

The speechwriter:  A brief education in politics.  Barton Swaim.  Simon & Schuster.  2015.

 

Barton Swaim’s sparkling memoir portrays a maverick governor of South Carolina whose two terms, 2003-11, straddled the Great Recession. 

Mark Sanford became famous as a fiscal masochist: He turned down federal money.  In 2009, Congress passed an $830 billion stimulus, the American Recovery and Reinvestment Act.   “The idea behind the stimulus was to pump large amounts of cash into the economy in order to ignite consumer spending and, in turn, growth,” Swaim explained.  “The two [reasons] that led [the governor] to oppose the policy with all his energy were these: The cash was borrowed, and most of it would pass from the federal government to state governments.  He understood the culture and habits of government well enough to know that that federal money wouldn’t be used to spur economic growth but to balance state budgets.”  

Wrong premises, wrong conclusion.  Most state constitutions require the government to balance its budget whether or not Capitol Hill is feeling generous.  Suppose that South Carolina collects $1 billion in tax revenues this year.  Then it will have to limit its spending to $1 billion.  Now suppose that Washington gives Charleston $100 million.  Then South Carolina can spend as much as $1.1 billion.  If it spends that $100 million on teachers and roads, then it will constitutionally create jobs and income now -- and economic capacity later, since educated workers can produce more and since roads cut delivery costs.  An increase in the capacity to produce is what economists mean by “economic growth” – economists, if not speechwriters.

Brother, can you spare a billion?

It appears that the 2009 stimulus will not boost economic growth by much.  According to the Congressional Budget Office, the financial think tank for Congress, most of its impact on output occurred in the first half of 2010.  In 2014, it lifted output by no more than a fifth of one percent.  The benefits of the stimulus were mainly short-run.       

Yes, it’s borrowed money.  But a recession may be the best time to borrow, since interest rates are low then.  The government may be able to pay off the loan out of the tax revenues created by the economic growth. 

Here’s an example.  Suppose that the interest rate on the loan is 1%.  Also suppose that the rate of economic growth is 2%.  Then the interest to be paid on the $100 million loan is $1 million.  The amount of income generated by economic growth is $2 million, so the government can easily pay its bills.

But… what if the rate of economic growth is less than 1%?  Is it then foolish to borrow?  Not necessarily.  In a recession, people lack jobs.  Putting them to work – any kind of work – will increase output and consequently income.  This may come at the expense of future taxpayers, but presumably they will be richer anyway than Americans today.

The 2009 stimulus may fit that case.  The CBO concluded this year that the $830-billion stimulus would increase the federal deficit – that is, spending that exceeds concurrent tax revenues – by $840 billion over the period 2009-19 (fiscal years, which start October 1).  Future taxpayers will be on the hook for $10 billion. 
    

Soaking the naïve  

A more compelling argument against a stimulus rests on the assumption that people are not fools. Suppose that the government borrows $100 million.  Taxpayers know that they must eventually pay off the loan, so they save $100 million now.  The government increases spending by $100 million, and households decrease spending by $100 million.  Overall spending doesn’t change.  The stimulus is a fake.

Economists call this phenomenon “Ricardian equivalence,” after David Ricardo, an English economist in the early 1800s.  Statistical studies indicate that it may sometimes occur.  An example arises from the decision of President George H. W. Bush in 1992 to reduce withholding of taxes in order to stimulate quick consumption.  Since the overall tax bill didn’t change, Ricardian theory predicted that people would simply save the freed-up money in order to pay their taxes when they finally came due; consumption would not rise. 

And in fact, when Matthew Shapiro and Joel Slemrod surveyed 381 taxpayers in households where at least one spouse was working, 57% said they would either save the money, use it to pay down debts, or revert to the original rate of withholding. 

On the other hand, it would be hard to argue that the federal government’s World War II spending of borrowed funds did not spur the US economy straight out of the Great Depression.  The Ricardian result does not always hold, because it rests on stringent assumptions – for example, that all households can borrow and save as much as they want.   -- Leon Taylor, tayloralmaty@gmail.com

Good reading

Congressional Budget Office.  Estimated impact of the American Recovery and Reinvestment Act on employment and economic output in 2014.  February 20, 2015.  https://www.cbo.gov/sites/default/files/114th-congress-2015-2016/reports/49958-ARRA.pdf

David Ricardo.  Essay on the funding system.  Reprinted in a collection by J. R. McCulloch, The works of David Ricardo.  Honolulu: University Press of the Pacific. 2002 [1888].

Matthew Shapiro and Joel Slemrod. Consumer response to the timing of income: Evidence from a change in tax withholding. American Economic Review 85:1.  Pages 274-83.  March 1995.

Wikipedia.  American Recovery and Reinvestment Act.